Nothing in economy a ‘given’

August 19, 2013

Recently, I have written about John Locke, then Adam Smith. Today, I focus on Friedrich Hayek.

If any 20th-century economist was an up-to-date man, it was Friedrich Hayek. He made fundamental contributions to the field of economics. His powerful contributions are most relevant today.

Hayek was the best-known advocate of what is now called Austrian Economics. Most of Hayek's work from the 1920s through the 1930s was in the Austrian theory of "business cycles."

The major problem for any economy, he argued, is how people's actions are coordinated. He noticed, as Adam Smith had, that the price system-free markets did a remarkable job of coordinating people's actions, even though that coordination was not part of anyone's intent. The market, said Hayek, was a spontaneous order. By spontaneous, Hayek meant unplanned - the market was not designed by anyone, but evolved slowly as the result of human actions. But the market does not work perfectly. What causes the market, asked Hayek, to fail to coordinate the plans of people, so that at times large numbers of people are unemployed?

One cause, he said, was increases in the money supply by the central bank. Such increases, he argued, would drive down interest rates, making credit artificially cheap. Businesspersons would then make capital investments that they would not have made had they understood that they were getting a distorted price signal from the credit market.

But capital investments are not homogeneous. Long-term investments are more sensitive to interest rates than short-term ones, just as long-term bonds are more interest-sensitive than treasury bills. Therefore, he concluded, artificially low interest rates not only cause investment to be artificially high, but also cause "mal investment" - too much investment in long-term projects relative to short-term ones, and the boom turns into a bust. Hayek saw the bust as a healthy and necessary readjustment. The way to avoid the busts, he argued, is to avoid the booms that cause them.

In the late 1930s and early 1940s, Hayek turned to the debate about whether socialist planning could work. He argued that it could not.

The reason socialist economists thought central planning could work, argued Hayek, was that they thought planners could take the given economic data and allocate resources accordingly. But Hayek pointed out that the data are not "given." The data do not exist and cannot exist in any one mind or small number of minds. Rather, each individual has the knowledge about particular resources and potential opportunities for using these resources that a central planner can never have. The virtue of the free market, argued Hayek, is that it gives the maximum latitude for people to use information that only they have. In short, the market process generates the data. Without markets, data are almost nonexistent.

In 1944, Hayek also attacked socialism from a very different angle. From his vantage point in Austria, Hayek had observed Germany very closely in the 1920s and early 1930s. After he moved to Britain, he noticed that many British socialists were advocating some of the same policies for government control over the lives of people he had seen advocated in Germany in the 1920s.

He had also seen that the Nazis really were National Socialists; that is, they were nationalists and socialists. So, Hayek wrote "The Road to Serfdom" to warn his fellow British citizens of the dangers of socialism. His basic argument was that government control of our economic lives amount to totalitarianism.

"Economic control is not merely control of a sector of human life which can be separated from the rest," he wrote. "It is the control of the means for all our ends."

There is no better way to conclude this column than to quote the late Milton Friedman, Nobel Laureate in Economics, who said about Hayek, "Over the years, I have again and again asked fellow believers in a free society how they managed to escape the contagion of their collectivist intellectual environment. No name has been mentioned more often as the source of enlightenment and understanding than Friedrich Hayek's. I, like others, owe him a great debt ... to broaden and deepen my understanding of the meaning and the requisites of a free society."

Dr. Robert L. Heichberger is professor emeritus at the State University of New York at Fredonia and distinguished professor at Capella University in Minneapolis, MN. All of the past columns can be viewed on www.fromourperspective.net/ Send comments to: Rheich@aol.com